Hyderabad: The recent scam in one of the largest urban cooperative banks, Punjab and Maharashtra Cooperative Bank (PMC), has turned the spotlight on the working of cooperative banks in the country.
Reserve Bank of India (RBI) imposed restrictions on withdrawals from this bank. In the last few weeks, bank customers have been in a state of panic and already four depositors have died.
RBI had to reassure the public that ‘the Indian banking is safe and stable and there is no need for panic. In this context, it is important to examine the current status, challenges and way forward for these banks in order to restore the confidence among the people and overall health of the financial sector.
Current Status and Challenges
The Cooperative institutions play an important role in credit delivery particularly to unbanked segments of the population. The Indian cooperative movement has its origins in the late 19th Century when it was attempted as an alternative to usurious moneylenders in villages.
Basically, the Cooperative Banks have been centred around communities and localities lending to small borrowers and businesses. The depositors are attracted to these banks because of higher interest rates and personal attention.
Currently, the cooperative system consisted of 1,551 urban cooperative banks (UCBs) and 96,612 rural coperatives in 2018. While rural cooperatives provide financial services in villages and small towns through their geographical and demographic outreach, the UCBs provide credit in urban and semi-urban areas.
It may be noted that the growth of cooperative banks, however, has not been commensurate with the overall growth of the banking sector. As a result, they accounted for only 11% of the total assets of the scheduled commercial banks (SCBs) in 2017 in comparison to 19% share in 2004-05.
RBI’s report on trend and progress of banking in India 2017-18 provides the current status of cooperative banks in India. Within rural cooperatives, performance varied in terms of asset quality and profitability. While State Cooperative Banks improved NPA ratios and profitability, both parameters deteriorated in the case of DCCBs.
The financial performance of long term cooperative institutiions in agriculture has been less than satisfactory and has deteriorated further.
Regarding urban cooperatives, the RBI data shows that although asset quality improved, overall profitability moderated. Among the 1551 banks, 26 were under ‘direction’ of the regulator and 46 had negative worth. There have been scams in urban cooperative banks.
One example is the Madhavpura Cooperative Bank issue in Gujarat in 2001 which turned ot to be huge because it had a significance percentage of assets as loans given to stock broker Ketan Parekh.
In the case of the recent scam in PMC, there were three problems:
- Major financial irregularities
- Failure of internal control and systems of the bank
- Wrong/underreporting of its exposures
It is well known that PMC bank has extended 73% of its assets to HDIL (Housing Development and Infrastructure Limited). This bank has hidden exposers using more than 21000 accounts to hide from RBI supervision. It is a fruad of a huge exposure to a single entity in the real estate sector which was camouflaged under a whole lot of dummy accounts.
Cooperative banks came directly under the RBI’s radar in 1966 but faced the problem of dual regulation. Urban cooperative banks are regulated and supervised by RBI and State Registrars of Cooperative Societies (RCS) in the case of single state and Central Registrar of Cooperative Societies (CRCS) in case of multi-state cooperative banks.
The RCS is in control of management of elections and many administrative issues as well as auditing. The RBI supervision includes all the regulatory aspects like granting of licence, maintaining cash reserve, statutory liquidity and capital adequacy ratios and inspection of these banks. But, there is a feeling that one did not have much control over cooperative banks as the RBI has over private sector banks because of dual control.
The RBI pursued an active licencing policy for UCBs during 1993-2004 which led to a sharp increase in their numbers. Subsequently, as the problems and stress in this sector became evident, RBI stopped new licences and enunciated appropriate regulatory and supervisory policies in its Vision Document involving merger/amalgamation of weak but viable UCBs and closure of unviable ones.
Despite regulatory checks in place, weak corporate governance, lack of professionalism and reluctance in technology adopted are some of the concerns. The role of cooperative banks declined with the expansion of scheduled commercial banks and adoption of technology. They are also facing competition from payment banks, small financial banks and NBFCs. There are also issues related to capital. Urban cooperatives can not raise capital through a public issue or issue of shares at a premium.
The problem in a cooperative structure is that you can not have a professional board. The board of directors of a cooperative bank is elected by the bank’s members and the process is often gamed by politicians to gain control of the bank. In many states, political control of such institutions plays a key role in the manifestation of the networks of political patronage, through loans as well as jobs at such institutions.
What is the way forward ?
There is a need to relook at the regulation and governance of cooperative banks in order to have trust of the depositors and other stakeholders.The regulator RBI and the government do well to re-evaluate the importance of co operative banks in the current financial landscape to avoid recurrence of such incidents.
There is a sense that governance is broken in some of the cooperative banks. Bank boards, auditors, bank management, rating agencies and regulators have been responsible for lack of governance and poor regulation. We need confidence building among depositors and other with better governance.
Although RBI has MOUs with state government, supervision is likely to be ineffective unless state governments cooperate in effecting regulations. RBI has been nudging cooperative lenders to act professionally. There was a committee under H. Malegam which recommended a board of management of fit and proper persons, other than the board of directors. The idea was to have a board of management in actual control of operations as opposed to elected directors.
There is a need for changes in selection of directors and they should have members with specialised knowledge and professional management skills.
In 2018, the RBI announced a scheme for voluntary transition of eligible urban cooperative banks into small finance banks in line with the recommendations of a high powered committee chaired by R. Gandhi. This would enable them in having most of the products which are currently permissible to commercial banks and help them in getting pan-India presence.
UCBs with a minimum net worth of Rs. 50 crores and above are eligible for the voluntary transition. But, not surprisingly there is a resistance from the sector to become small financial banks. RBI can say that for further growth the larger urban cooperative banks should appoint a board of management that meets the norms for fit and proper or become small financial banks.
RBI also said that for urban cooperative banks there could be an umbrella organisation promoted by the banks themselves to raise capital from the market as a joint stock company. Merger of weak banks with strong banks has to be encouraged. Use of technology has to be promoted in cooperative banks to compete with other banks.
We should also look at the extent of deposits of other cooperative banks in such large urban cooperative bank. Perhaps it is time to review whether an urban cooperative bank should accept deposits of other urban cooperative banks. The failure of a big-UCB deposits are significant. Keeping in view the depositors’ interest and also financial stability issue, the policy of inter-UCB deposit needs to be revisited.
Insurance of deposits is another issue in Indian banking. Currently, the deposit insurance cover is Rs. 1 lakh per depositor by the Deposit Insurance and Credit Guarantee Corporation (DICGC). A revision in India’s bank deposit insurance cover which is a way below average is long overdue. But, bigger insurance cover alone will not solve the problem. History shows that in India depositors in troubled banks often endure few years and surmount many hurdles before they get their hands on the insurance money.
RBI and Government have to look at the issue of increasing insurance and quick settlement. The government is reported to be reviewing insurance cover for bank deposits. This is an important aspect and it is worth debating whether depositors should be made to take a hit at all in the case of a bank failure. The problems in the affected bank should be solved as soon as possible so that depositors get their deposits back faster.
To conclude, recent developments in cooperative banks have provided a good opportunity to come up with a comprehensive framework, as India does not yet have a robust enough financial system to protect the common man’s savings.
Finance Minister Nirmala Sitharaman has said the government will assess if legislative amendments are needed to implement effective regulation. She had asked secretaries of the ministry along with RBI to study the developments in the cooperative sector issue in detail.
The ways in which the respective acts will be amended will also be talked about in these meetings. If that happens, it might just be the silver lining on the PMC crisis. Hopefully, the confidence of customers of cooperative banks will return if RBI and government act quickly.
(Written by S. Mahendra Dev, Vice Chancellor, IGIDR, Mumbai)
